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The private equity industry is teeming with ambitious deal-doers looking to set up their own shops and be their own bosses. But successfully raising the first fund is easier said than done.

The number of first-time funds focused on Europe that got off the ground last year hit their lowest level since records began in 2000, according to data provider Preqin. There were 46 funds that reached a final close, compared with 54 in 2012 and 127 at the market peak in 2008. By the value of first-time funds, it was the worst year for more than a decade. The $7.5 billion raised was slightly down on $7.7 billion in 2012 and significantly lower than the $29.8 billion raised in 2007. The last time it fell so low was in 2002, when $6 billion was raised.

Nils Rode, a managing director and co-head of investment management at Zurich-based private equity fund of funds manager Adveq, said the figures were not surprising given the choice among more established fund managers. “If you look at Europe alone, there are more than 700 buyout funds, at least on our long list.

At the same time, limited partners are consolidating rather than expanding the number of their relationships, so that leaves less room for new funds to be added to the market,” he said.

Global investor appetite for first-time funds has declined. Only 19% of investors surveyed by Preqin in
December 2013 said they would invest in first-time funds, compared with 29% in 2012. More than half (56%) said they would not invest in first-time funds – a figure that has remained relatively constant for the past few years.

Despite the difficulties there have been a few success stories. Debut fundraisings from Nordic-focused buyout firms Solix, which recently closed with commitments of roughly €270 million, and Adelis Equity Partners, which raised €420 million last November, as well as LDC spin-out NorthEdge Capital’s success in raising £225 million last year, have given first-time managers hope.

There are 136 Europe-focused fund managers in the market looking to raise their first funds at the moment. Financial News canvassed the industry for 10 tips on how they can succeed.

1. Get the team right

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First-time managers stand a bigger chance of raising money if the team has spun out from a successful firm, said Rode. At the very least, investors want to see several people that have worked together in the past in broadly the same strategy that the new fund will focus on.

James Moore, global co-head of the private funds group at investment bank UBS, said: “Any new team may all have great individual track records, but what happens if there are major disagreements? If you have a tried and tested team that has successfully navigated their way through difficult periods, it is more likely that the team dynamics works.”

2. Prove your track record

Having a great track record is one thing, but being able to prove it to investors is another. New managers must ensure they have a severance letter from previous employers that allows them to use their track record in marketing documentation.

If a departure from a previous employer was less than amicable, managers need a solid list of referees, such as investors and portfolio company chief executives, to allow new investors to look into their record. Investors do the most extensive referencing for first-time managers.

Adveq, for example, would do between 20 and 30 references for first-time managers, including those not on the reference list provided by the new team.

3. Identify potential targets

Having a handful of pre-identified deals to show investors is essential in raising a fund, but can be tricky without having the money lined up to pay for them.

NorthEdge managing partner Grant Berry said his team spent the early stages of their three years’ fundraising meeting companies and introducing them to other private equity firms, with NorthEdge looking to secure a corporate finance role on the deal instead.

Berry said: “We were almost corporate finance advisers in the very early stages. But then, as we got closer to a first close, we were able to say to the teams that were looking for capital ‘If you bear with us, we can provide the equity because we’re now pretty confident that we’re going to get to a first close’.”

4. Be different

Having a highly differentiated strategy and not just another “me too” offering is essential to raising a first-time fund. This can mean focusing on a size that other successful funds have moved away from as they have grown bigger, or having a high degree of specialisation in a certain sub-region or industry.

It can also help if a first-time firm teams up with a more established firm, said Rode. These relationships can range from having an informal partnership with existing funds that offer support, references and an introduction to investors to more formal relationships where the new group shares the brand name of the established group as well as some back-office functions, support in fundraising and profit sharing.

5. Have existing investor relationships

Maintaining relationships with investors from a previous firm may help new managers to secure commitments from those investors for their new fund.

This was evident with Solix, a firm set up by a founding partner of Nordic mid-market buyout firm Altor, which recently closed its debut fund with commitments from investors in Altor’s funds.

In cases such as NorthEdge, where the founding partners were previously investing from the balance sheet of Lloyds Banking Group and so did not have a network of investors, this might be more difficult.
Moore said: “Having some friends or family or cornerstone money behind you to get you to first base is
hugely beneficial, and also gives confidence to other investors.”

6. Consider placement agents

First-time managers that do not have a network of relationships with investors may decide to hire a placement agent to help them raise their fund.

While this costs money, placement agents can help a new team to identify investors that will be favourable towards their strategy and weed out those not permitted to invest in first-time funds.

Berry, who used UBS as a placement agent for NorthEdge’s first fund, said: “We felt that we could have raised a fund on our own, but the size of that fund would probably have been less than £100 million and it would’ve taken us even longer.

“We’ll be using a placement agent on the next fund, and we’re a lot more connected now than we were three years ago.”

7. Invest your own money

A commitment to a fund from a company’s own partners, commonly known as skin in the game, is a good way to show that the team has confidence in its own offering.

While more established fund managers who have generated some wealth during their careers would generally be expected to commit at least 2% or 3% of total funds raised, investors would typically expect new managers with less personal wealth to commit 1% or 2% of total funds raised to their first fund.

8. Try deal-by-deal financing instead

Many first-time managers have chosen to use a deal-by-deal financing model to pay for acquisitions before attempting to raise a fund. This gives investors the right to look at the businesses before they invest in them, increasing the likelihood of a manager raising money.

But the deal-by-deal route has disadvantages. Eamon Devlin, a managing partner at law firm MJ Hudson, said deals that fall through would be subject to break fees, which can be costly for a firm with no fee income
to pay for them.

Deal-by-deal funds also offer much lower returns for fund managers, usually 1% management fee and 10% carried interest as opposed to the 2/20 model offered by traditional funds.

9. Offer up some equity

A new firm might choose to sell part of its management company to cornerstone investors, which would help it to raise money to pay for legal costs and other administrative expenses. In return, a fund manager will offer the cornerstone investors a portion of future carried interest and management fees, as well as access to dealflow and a say in the governance of the firm.

Devlin said: “It’s an expensive way to raise money because you’re basically giving away some of your future profits, but others would say you’re better having half a loaf than no loaf.”

10. Provide co-investment opportunities

Investors have increased the number of direct investments they make in businesses alongside fund managers in recent years in an effort to avoid paying management fees and carried interest and to have greater control over their investments.

This can also be a good strategy to entice investors into a first-time fund, said Rode. He added: “Offering co-investments is something that many established fund managers do these days, and it’s something that first-time managers do in order to increase the attractiveness of the value proposition.”

--This article was first published in the print edition of Financial News dated May 26, 2014